February 18, 2020

Bankruptcy Alert – The Small Business Reorganization Act

Prior to the enactment of SBRA, a small business debtor seeking relief under Chapter 11 had to follow the same rules and procedures like a large, Fortune 500 company like General Motors. As a result, many struggling, small business debtors could not afford the significant amount of professional fees and costs associated with a traditional Chapter 11 filing. Further, there was no assurance that the small business owner would retain his ownership interests in a company upon emergence from bankruptcy. This resulted in the perception that the bankruptcy medicine would either kill the patient, or otherwise wasn’t worth taking.

The SBRA is designed to promulgate Chapter 11 as a more attractive option for small businesses who are facing financial hardship.

Overview of SBRA

Some of the most significant changes of the SBRA include the following:

  1. Qualification:  The SBRA applies only to a “small business debtor,” which is defined as any person engaged in commercial or business activities who has less than $2,725,625 in total debt, and for whom at least 50% such debt arose from its business and commercial activities.
  2. Plan Confirmation Process: The plan confirmation process, one of the costliest aspects of Chapter 11, has been significantly streamlined. A small business debtor is no longer required to prepare the lengthy, tedious disclosure statement. Only a debtor may propose the reorganization plan, and the debtor does not need to solicit votes in order to confirm the reorganization plan. A plan may be confirmed even without the support of any class of creditors.
  3. Absolute Priority Rule: One of the most significant changes under the SBRA is the elimination of the absolute priority rule. In traditional Chapter 11 cases, under the absolute priority rule, a plan of reorganization cannot be confirmed, and ownership cannot retain its interests in the business, unless unsecured creditors are paid in full or accept a plan. However, under the SBRA, small business owners may retain equity in the small business without paying creditors in full. A plan is confirmable so long as the plan does not discriminate unfairly and is fair and equitable to each class of claims or creditors who have not accepted the plan. This is a significant development because it provides an easier path for a business owner to enter Chapter 11 without fear of losing his or her business.
  4. Future Income: The plan must provide that all the debtor’s projected, disposable income for not less than three years, but no more than five years, will be applied toward payments to creditors under the plan.
  5. Trustee: The United States Trustee will appoint a non-operating trustee. This trustee will not operate the business but will be responsible for an accounting of all estate property, monitoring debtor’s progress toward confirmation of a plan of reorganization and ensuring that distributions are made to creditors under the plan.
  6. Quarterly Fees: Unlike in a traditional Chapter 11 case, small business Chapter 11 debtors are not required to pay quarterly fees to the United States Trustee, resulting in a significant savings of roughly $5,000 or more per quarter in many cases.
  7. No Committee: Creditor committees will not be appointed unless ordered by the bankruptcy court for cause.
Changes to Preferential Transfers to All Bankruptcy Cases

The SBRA also modified the treatment of preferential transfer cases for all bankruptcy filings, and not just small business cases. Under the new legislation, a bankruptcy trustee or debtor-in-possession may avoid transfers of property of the debtor “based on reasonable due diligence in the circumstances of the case and taking into account a party’s known or reasonably knowable affirmative defenses.” This change apparently requires the trustee to exercise reasonable due diligence before initiating a preferential transfer action and to consider known or reasonably knowable affirmative defenses. The SBRA does not explain what constitutes “reasonable due diligence,” nor does it explain what may constitute a “known or reasonable knowable” affirmative defense.

Analysis

The changes in law relating to preferential transfers should require a trustee to think twice before filing a lawsuit to recover a preferential transfer. Some trustees have been accused of making demands and filing lawsuits against creditors without performing any reasonable amount of due diligence. The changes seem to prevent a trustee from suing first and analyzing the merits of a case later. Still, it is important to note that the burden is still on a defendant to establish defenses under 11 U.S.C. 547(c), like the common subsequent new value and ordinary course of business defenses.

There is no question that the drafters of the SBRA intend for the changes to result in reduced costs, and an increased prospect for reorganization of a small business debtor. Like many pieces of new legislation, it is not clear whether all changes will have the intended effect. While some significant costs, as outlined above, are eliminated, a debtor will be required to compensate a trustee for his or her work. Further, there may be significant litigation over what constitutes projected disposable income that must be paid to creditors. Nevertheless, many of the revisions to the plan confirmation process appear to be definitive ‘game changers’ that will increase the prospects of a successful reorganization without a protracted confirmation battle that a small business can ill afford.

 Jason W. Bank is the chair of the firm’s Bankruptcy and Restructuring department. He focuses his practice in the areas of commercial bankruptcy, out-of-court workouts, corporate restructuring and creditors’ rights. He has successfully guided numerous businesses through out-of-court restructurings and Chapter 11 reorganizations. He has negotiated resolutions of complex financial issues and debtor-creditor disputes and achieved consensual restructurings while avoiding bankruptcy or litigation.

 

Brandi Dobbs Brandi M. Dobbs is an associate at Kerr Russell who supports the business and litigation needs of clients. She focuses on bankruptcy and restructuring. Brandi has successfully guided consumer debtors through Chapter 7 and assisted business debtors through the Chapter 11 process.

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